How to value bitcoin

The sharp rise in the price of bitcoin and some other cryptocurrencies since the start of 2017 has created enormous interest in this market. Many people see it is a chance to make money, and they don’t want to miss out.

However, there are plenty of sceptics. The arguments include that bitcoin can’t be a real currency, that there is no rational place for it in an investment portfolio, and, at the extreme, that it’s simply a fraud.

Supporters, however, say that these arguments are missing the point. Speaking at the Old Mutual Tomorrow event in Cape Town on Friday, venture capitalist Vusi Thembekwayo said that when it comes to cryptocurrencies people shouldn’t get stuck in “second industrial complex” thinking.

How do you value the rand? Why do you own rands versus dollars? Why would you buy Swiss francs?

“That thinking assimilates value to a specific world,” he argued. “A world that is industrialised, that functions on a balance sheet, and that values a thing based on an asset pegged to a currency value.”

The argument is that the world of cryptocurrencies is part of the fourth industrial revolution, where value must be viewed differently because this is a world where value is created differently.

But the question remains, if you are going to put money into bitcoin, how do know whether the price you’re paying is reasonable? And that is a question that even the experts really struggle to answer.

“Bitcoin is the world’s first digital currency, or first digital commodity,” argued Vinny Lingham, co-founder of Civic. “So, how is it any different from any country that issues its own currency? How do you value the rand? Why do you own rands versus dollars? Why would you buy Swiss francs?

Underlying economic activity

“Any currency is an index of the underlying economic activity in that country,” he said. “Bitcoin is an index currently of all the other cryptocurrency activities in the digital economy.”

Technically, it’s not a very good argument. Exchange rates are far more than just a measure of underlying economic activity. A simple example is that Botswana’s pula is significantly stronger than the South African rand, but its economy is 20 times smaller.

Vinny Lingham

Exchange rates are influenced by many things, including inflation, interest rates, current account deficits, government debt and political stability. None of those things can be factored into a valuation of bitcoin.

Yet, it’s worth considering Lingham’s broader point, which is that there is a new kind of economy emerging and maybe bitcoin should be seen as a proxy for it.

“This is an alternative system,” said Thembekwayo. “And that alternative system will take off because it is able to create value at lower marginal cost.”

This is an alternative system. And that alternative system will take off because it is able to create value at lower marginal cost

There is little question that the possibilities of the blockchain are fundamentally exciting. There are already fascinating examples of developments in this space.

“You will start seeing companies listing their shares onto a blockchain and those shares being traded between wallets rather than on exchanges,” said Lingham. “That’s part of this very powerful move towards decentralisation.”

This would also mean that you could trade these shares anywhere in the world. Investors would no longer be restricted by where the company was listed.

Along the same lines is that some companies are already raising capital not through traditional initial public offerings on recognised exchanges, but rather through unregulated initial coin offerings (ICOs). This involves investors buying a share in a project or company using cryptocurrencies on a blockchain.

Crowd funding

“ICOs and other crowd funding allows for entrepreneurs to fund new projects without going through central custodians for that value,” Lingham said. “Yes, there will be scams, and there will be failures, but it’s very likely that more ventures in the future will be less driven to find centralised vehicles, and more to crowd-funding type solutions.”

That’s the kind of economy that bitcoin and blockchain technology are already enabling.

“It’s the future,” said Thembekwayo. “You just want to get in. It’s like going on a date — it’s a function of faith.”

Lingham did however suggest that cryptocurrencies should still be approached with prudence.

“The biggest risk right now in cryptocurrencies is people who don’t know what they are doing buying them,” he said. “I wouldn’t be investing directly in cryptocurrencies unless I was technically proficient.”

He recommended that people who want to get exposure but aren’t experts themselves, should rather look to use a vehicle like a cryptocurrency hedge fund.

“There are people in Silicon Valley with the technical skills and the expertise,” he said. “They may not get you the 200% return on a specific currency that goes through the roof, because they have a more conservative approach, but they will get you exposure to the sector and give you returns that are going to be outsized.”

This article was originally published on Moneyweb and is used here with permission

Trending Posts

1 Comment

Vinny Lingham’s statement ““Any currency is an index of the underlying economic activity in that country,” …” is absolutely correct. He didn’t say economic size, and the broader term economic activity does factor in all aspects relevant to exchange rates. It most notably encompasses the point of trust. How much can investors trust a certain currency, underpinned by its economy. Countries where finance ministers are fired by a criminal president to get easy access to state coffers enjoy little trust, even more so when they are size-able.